HOW BROKERS FACILITATE TRADE FOR LONG-TERM CLIENTS IN COMPETITIVE SECURITIES MARKETS

In adverse-selection models of security market microstructure, a market maker could enhance efficiency if he or she were willing to sustain short-term trading losses. We show that this desirable activity can be supported as a self-enforcing agree ment between broker-dealers and long-lived clients. An implication is that brokers who sustain such losses should charge higher fees to long-term clients for trades where the broker merely receives a commission. This prediction is supported by an analysis of brokerage rates on the Australian Stock Exchange. By contrast, market makers who make trading profits charge lower agency fees to large, long-term clients.